Contrary to some predictions, Bitcoin is fast becoming an accepted means of transacting. Big companies like online retailer Overstock.com and mobile operator AT&T already allow customers to pay in bitcoin. And the list of companies that accept bitcoin keeps growing every day.
On a basic level, this trend proves that bitcoin is not a worthless virtual currency as critics love to claim, but it also represents something more fundamental: Bitcoin’s potential to replace legacy payment processing systems like Visa and MasterCard.
This may seem absurd, but there are many advantages that Bitcoin offers both consumers and merchants. And if you know anything about the creative destruction inherent in capitalist societies, Bitcoin replacing credit cards is only a matter of time.
Let’s look at the anatomy of credit cards and Bitcoin payments before highlighting the differences between the two.
How do credit card payments work?
When you pay for a product with your credit card at a point of sale, the money doesn’t go directly to the merchant as you might think. The actual process is a kind of dance, involving you (the cardholder), your bank, the credit card network, the merchant’s bank, and the merchant.
Here’s an example to illustrate:
Imagine that you (the cardholder) pay for a pair of sneakers with your Visa card at Bob’s store downtown. Essentially, you are authorizing Bob (the merchant) to “pull” the payment from your account. But that payment must go through several intermediaries before Bob receives it.
First, the credit card network (Visa) relays the payment request to your bank. Your bank then authorizes Visa’s request to transfer money from your account to Bob’s bank. The last step involves Bob’s bank accepting payment and depositing money into Bob’s account.
From this illustration, you can see that Visa is just one player in the payments network. It just facilitates the interaction between the different parts of the ecosystem. This is a crucial fact that many tend to miss, especially when comparing Bitcoin to credit cards.
How do Bitcoin payments work?
To pay in bitcoin, you transfer coins from your wallet to the recipient’s address by signing the transaction with your private key. The payment is recorded on the Bitcoin blockchain, which is similar to a ledger used to record transactions. The difference is that this book is public and entries cannot be modified or deleted.
Compared to your credit card, Bitcoin “pushes” the payment directly to the merchant. There are no third parties involved in processing the transaction, which is why Bitcoin is described in the white paper as a “peer-to-peer electronic money system”.
If we apply this concept to the previous example, you can see how Bitcoin payments differ.
If you want to pay Bob with bitcoin, all you need is a wallet containing bitcoin and Bob’s public address on the blockchain. You would then transfer a specified amount of bitcoin to Bob’s address, authorizing the transaction with a digital signature generated from your private key.
Bob will immediately receive the money in his wallet as soon as the payment is confirmed by the miners, without going through the authorization, exchange and settlement processes used with credit cards. So Bitcoin payments are like wire transfers – the money goes directly from the customer to the buyer.
Now, let’s dig deeper and understand how Bitcoin’s features make it better for processing transactions.
Why should Bitcoin replace credit cards?
When comparing Bitcoin to credit cards, critics often highlight the disparities in the processing speeds of both systems. For example, Visa handles 24,000 transactions per second (TPS), compared to Bitcoin’s five to seven TPS.
However, these comparisons leave out many crucial details. Swiping the credit card does not automatically deposit money into the merchant account. Instead, credit card companies take several days to authorize and release the payment.
Bitcoin is designed as an independent bank and payments network. You only need to move coins from one address on the blockchain to another if you are paying with bitcoin. This process completes in 10 minutes or less and provides transaction completion, unlike a credit card payment.
Additionally, Layer 2 solutions like the Lightning Network can scale Bitcoin at speeds to rival the fastest payment systems. The Lightning Network offloads transactions from the main chain, reducing transaction confirmation times and increasing network throughput. While Lightning Network adoption is still growing, it could potentially disrupt this world’s Visas and MasterCards in the future.
The downside of relying on multiple parties, such as credit card payments, is that it increases the risk of a malicious attack. When you enter your credit card details on an e-commerce site, you are authorizing them to deduct money from your account. This is not a problem if the company is trustworthy, but what happens when an unscrupulous hacker steals this information?
Large companies including Equifax, Neiman Marcus, Target and Marriott Hotels have fallen victim to targeted attacks designed to steal customers’ credit card information. These thefts often expose customers to risk as hackers can use stolen card details to complete unauthorized purchases.
The security risks of credit card details also extend to physical purchases. Card skimmers are notorious for stealing credit card information from point-of-sale devices such as self-service gas stations or cashiers in retail stores. They can deplete their accounts in minutes with this information.
Except for the amount and recipient address, Bitcoin does not require any other information to process a payment. You just need to authorize the transaction with a private key — securely stored in your wallet — and that’s it.
A hacker would need to compromise your device or use social engineering techniques like phishing to steal your keys and initiate a Bitcoin payment. However, these issues can be easily avoided by watching fake websites, storing keys securely, or using a multisig wallet.
Business owners can also benefit from Bitcoin’s secure network. The irreversible nature of Bitcoin payments prevents chargeback fraud, where buyers receive goods and then cancel the payment later. Companies will not be tasked with protecting sensitive credit card information, eliminating the need for costly compliance measures from the payment card industry.
Lower transaction fees
Credit card providers charge fees for processing payments, which can be up to 3% of the original purchase. As some merchants have low profit margins, they often have no option but to pass these costs on to buyers.
Bitcoin isn’t cheap either; transaction fees can increase, but tier 2 solutions like the Lightning Network can solve this problem. The average fee to process a transaction on the Lightning Network is one satoshi, equivalent to 0.00000001 BTC or $0.0004. With fees so low, it’s easy to see why companies are interested in integrating Bitcoin-powered Lightning payments into their revenue model.
Cheap transaction fees benefit businesses and buyers. Business owners would not have charges eating up their profit margins, while customers can pay for the products without incurring extra costs. If this sounds like a win-win solution, then you are starting to see the true value of Bitcoin.
You can’t just walk into a bank and say, “Hey, can I get a credit card?” and wait for one to magically appear. Not. Each bank you visit will have you complete a lengthy registration process before issuing a card. The process is the same, if not longer, for merchants who want to set up point-of-sale systems with a credit card provider.
With Bitcoin, all you need to do is set up a wallet and generate your keys to start receiving and sending payments. There are many free Bitcoin wallets that you can use, whether as mobile apps, desktop software, or web apps. And the application process is usually simple enough for even the least technical people.
The benefits of Bitcoin’s simplicity may not seem obvious, especially if you live in a western country with well-ordered banking systems. In developing countries, where things like creating a bank account or getting a credit card are next to impossible for most people, Bitcoin’s peer-to-peer cash system is a godsend.
Bitcoin can improve commerce by allowing unbanked individuals to pay for products as long as they have a mobile device connected to the internet. It could also make it easier for small businesses to set up payment channels without the usual paperwork.
Privacy and anonymity
By design, Bitcoin transactions are pseudonymous: the blockchain only records the public addresses of the parties and the value exchanged. No one can know who you are or what you paid for by looking for a transaction on the blockchain.
Many people associate anonymous Bitcoin transactions with right-wing extremists, terrorists, or other criminals who need to bypass traditional banks. However, even ordinary people who buy legal goods may not want their identities linked to the purchases for different reasons.
For example, a person who buys an adult toy online prefers a more discreet purchase method than a credit card. Additionally, payment providers are known to block purchases of products like marijuana despite being legal.
Even if you’re not making transactions that need to be kept private, think twice before buying products online. It is an open secret that credit card companies sell user data to advertisers and fuel ad targeting campaigns.
Every time you pay online with your credit card, someone is using that data to target you with ads. Did you order a Dyson vacuum last night? You can expect some “Best vacuum cleaner for your home!” ads start appearing whenever you open a page.
Companies don’t store your information when you pay with bitcoin, so you can shop with peace of mind. They also cannot sell your data to advertisers, so your browser will not be filled with intrusive ads.
Although Bitcoin receives a lot of negative press, its value as an efficient payment system cannot be denied. For businesses, accepting bitcoin payments means reducing transaction wait times, reducing chargeback fraud, and paying lower processing fees. For buyers, Bitcoin offers a secure, private, fast and simple way to pay for goods and services.
With new enhancements like the Lightning Network, acceptance of bitcoin payments will continue to grow. Over time, Bitcoin could do consumers and merchants a favor and end the monopoly of credit card providers.
This is a guest post by Emmanuel Awosika. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.